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Interest Rates Staying Low

Bond yields have fallen around the world over the past week driven lower by weak jobs data in the United States and Bank of Japan extraordinary policy easing. In the United States the March jobs report was much weaker than expected with employment ahead only 88,000 rather than the near 200,000 expected and February’s rise of 268,000. The unemployment rate actually managed a decline to 7.6% from 7.7% but that was because people left the workforce. The participation rate is now the lowest since 1979 showing just how despondent people are about finding a job. Had the rate sat at the long term average of 65% the current unemployment rate would be 10%.

The weak data mean that the Federal Reserve is not close to easing off in its money printing exercise and that weight of money argument is a factor which limited the decline in the US sharemarket following the jobs news and saw bond yields fall.

But yields have also been pressed lower by the larger than expected money printing programme announced last week by the Bank of Japan. There are expectations that investors will seek better yielding assets outside of Japan and hence falls in bond yields around the planet – including our own.

Domestically we have seen NZ wholesale interest rates edge down during the week as detailed in the table below. Given the continuing easy policy stances offshore, the effects of the drought on the immediate speed of growth in the NZ economy, March’s weak debit and credit card data, and the extra upward pressure on the NZD due to events overseas, there is little prospect of NZ monetary policy tightening for a year or so.

This means borrowers can look forward to a continuing low interest rate environment which as history tells us is both a negative and a positive. For conservative investors it is a negative which as each month goes by will see more and more people look for higher yielding assets than bank term deposits. This is what happened in 1992 when inflation and interest rates plunged and old folk started throwing their money at finance companies. This time around that option is not so easy (yet) but the search is underway and some will be taking their money into residential and commercial property investment.

As I have noted here a number of times in recent years, it is up to those of us with a bit above average nous to say to our elderly friends and relatives that if they chase yield then they are taking on higher risk and should things go wrong their ability to recover is going to be very low. They should sit down, take a breath and simply admit that one of the ways in which NZ is hit by the ongoing effects of the global financial crisis is that conservative investors in little old New Zealand and in fact all around the planet, get penalised through low returns. Accept it and go back to watching ducks and TVs.

But what about borrowers? Isn’t this ongoing low rate environment great for them? Not as great as you might think. Young people freshly leveraging themselves into a dwelling are going to start thinking that these low rates are the norm. They will take on too much debt, fail to maximise principal repayments in the early years of their loans, and get badly caught out when our central bank eventually has to respond to inflationary pressures over 2015 – 17.

The Reserve Bank knows that this cycle it has time on its side – it can sit back waiting to see how things go knowing that because hardly anyone is borrowing at 3 – 5 year fixed rates the impact of a cash rate change will be very quick. That quickness will come not just through most borrowers sitting floating and being hit straight away by official cash rate rises, but young people being surprised that rates can go up and getting eventually terrified by people like myself warning of how high floating rates have gone in the past.